Chapter 7 and Federal Taxes

[n152sm]

I had a small business that had to be closed. We have TRFP, SBOE, and State taxes that we are personally liable for. We have a couple of judgement leins from lawsuits that I had no way to financially support a defense.

We filed for CH7 personally (pro se) and since the business had no assets left we just dissolved the corp.

What is our best approach for removing leins against us personally that were related to the business, or what would our suggested approach be to settle the debt since we will never be able to personally pay it in full in our lifetime (without hitting the lotto)?

[spearmint]

Ok, time to give a "simple" rundown on taxes and bankruptcy. Note, even many BK attorney's don't know the ins-and-outs of taxes and BK.

Context:

I am discussing personal tax obligations which come in two varieties, 1040 Income Tax, or the Trust Fund Recovery Penalty ("TFRP"). You small business owners may run afoul of the TFRP if you didn't pay your Federal Tax Deposits relative to your employee withholding (Form 941) and therefore you get assessed personally for the withholding portion of your 941 Withholding. However, TFRP is easy in BK, the TFRP CANNOT BE DISCHARGED IN BK, EVER. But, there are some options with regard to personal income tax debt.

Discharge Rules for Taxes

So, the #1 questions, what Federal Income Taxes can be discharged in BK? There are basically 4 rules:

1. The 3 year rule. An income tax can be discharged if the Tax Return Due Date is 3 years prior to your BK petition filing date. This rule assumes the tax return was filed.
Example: ALL 1040's are due April 15. Thus, the most recent tax you could discharge this year (2008) would be income taxes from tax year 2004 because the due date for that return was April 15, 2005 and that date is more than 3 years ago.
Caveat: The extension date COUNTS. Thus, if you filed an extension for tax year 2004 so that your return was due in October 2005, that same tax debt WOULD NOT be dischargeable until November of 2008. Also, the time runs from the Due date, so if you filed your return early--say Feb '05--you still must wait 3 years from April 15.

2. The 2 year rule. For taxes that meet the 3 year rule, but you filed a LATE return, you must wait 2 years to discharge the tax from the date you filed that late return.
Example: You owe for 2002 (hence, Due date was Apr 15, 2003 satisfying the 3 year rule), but you did not actually file the 2002 1040 until April of 2006. That IRS debt can be discharged NOW because you filed the return more than 2 years ago and the due date of the return satisfies the 3 year rule.

3. The 8 month audit rule: If you are audited and ADDITIONAL tax is assessed, you must wait 8 months before you can file a BK petition to discharge that additional tax.

4. The fraud rule: The IRS can challenge the discharge of tax debt if you committed any sort of fraud. Keep in mind, BK fraud is less strenous than regular fraud in that the creditor normally need not prove "actual" intent.

Oh wait, Federal Tax Liens

IRS DEBT IS TECHNICALLY SECURED DEBT.

This is where most BK attorney's drop the ball. By operation of law, the IRS has a lien on all property of the debtor whenever a tax liability is created, the govt. makes a demand for payment, and you don't pay. The lien exists regardless if the IRS files a Notice of Federal Tax Lien. All the Notice does is put the IRS in 1st place over certain creditors, but the lien exists and is created by statute.

Whether this is an issue for you depends on whether you have any assets. If you own a house, this tax lien becomes problematic. As with any lien, the lien survives the BK. Thus, if you owe $40K to the IRS and have $50K in home equity, the IRS can foreclose that lien after your BK discharge even if the underlying tax debt is dischargeable. However, at the same time, the value of the lien is established at the time of filing petition. Let me explain...

So, what can you do? In today's real estate market you can do a quasi lien strip. Lets say you owe the IRS $40k, but only have $5K in home equity at the time you file the petition (i.e. the equity is Fair market value - superior liens to IRS, i.e. your mortgages). You need to file a Motion to Determine Value of Lien with the BK court. This act starts an adversarial proceeding. The reason to do so is to establish the value of the IRS's lien. Take this one step further, if there is no value to the home, then the lien attaches to no value and you can extinguish the lien.

If you don't file that adversarial proceeding, you enter into a legal grey area. The IRS has a lien for the full amount of the tax liability, that lien survives the BK even though the underlying tax is discharged as to you personally. Thus, in that respect, the IRS debt is no different than a non-reaffirmed mortgage; you have discharged your "personal" responsibility to pay the debt, but your assets (i.e. home) remain liable. If you don't file the Adversarial in BK, you are not without hope, but you will create one complicated, difficult, and EXPENSIVE mess to clean up that few attorney's or tax professionals are equipped to handle.

FEEL FREE TO POST COMMENTS AND QUESTIONS

But I thought you absolutely HAD to pay back taxes owing to the IRS, i.e. they are not dischargeable in BK.

[spearmint]

I am in the same boat. Didn't file for a number of years (long story - ill health) and now they are all being filed this year. Result - large tax debt.

What will happen? Do I have to pay the IRS monthly payments for three years and after that I can discharge them? How does that situation relate to the Ch13 I am about to file now?

[n152sm]

We had a small business that we had to close. I have TFRP, SBOE, and State Taxes that we are personally liable for, as well as a default judgement that I did not have the financial means to defend against.

We filed Chapter 7 personally, and since the business had no more assets, we dissolved the corporation.

What is the best approach to removing the leins against us (TAXES and Default Judgements)? Is there a way to eliminate or settle the unpaid business taxes that we are personally liable for - since there is no way we will be able to afford them personally in our lifetime (unless we hit the lotto!)?

Also - we borrowed against our home (HELOC / 2nd loan) to try and keep the business going (bad move). Now the first loan is 625K, the HELOC is 100K, and the house value is $600K. Since the HELOC is discharged in Chapter 7, is there any way to remove the lein that the HELOC holds on our home since there is no value/equity above the first mortgage? I have heard about Ch7 followed by Ch13 (or called a Ch20)....is this an option you'd recommend?

[HHM]

We had a small business that we had to close. I have TFRP, SBOE, and State Taxes that we are personally liable for, as well as a default judgement that I did not have the financial means to defend against.

We filed Chapter 7 personally, and since the business had no more assets, we dissolved the corporation.

What is the best approach to removing the leins against us (TAXES and Default Judgements)? Is there a way to eliminate or settle the unpaid business taxes that we are personally liable for - since there is no way we will be able to afford them personally in our lifetime (unless we hit the lotto!)?

Also - we borrowed against our home (HELOC / 2nd loan) to try and keep the business going (bad move). Now the first loan is 625K, the HELOC is 100K, and the house value is $600K. Since the HELOC is discharged in Chapter 7, is there any way to remove the lein that the HELOC holds on our home since there is no value/equity above the first mortgage? I have heard about Ch7 followed by Ch13 (or called a Ch20)....is this an option you'd recommend?

Those types of taxes are non-dischargeable in BK, TFRP SBOE etc. You will have to work directly with the taxing authority to resolve the situation. You can attempt an Offer in Compromise for the TFRP, for the state taxes, what you can do depends on what programs the state has available. Ganerally, your better off dealing with the state first because States are harder to deal with and need to be paid.

[cinderella]

State Taxes.

My attorney will not start my case unless I have filed the last 3 years of State Taxes-Georgia. I am getting conflicting information. I was told once you are only required to file back taxes if you plan to file a chapter 13. I am filing a Chapter 7. I am afraid to file because I know I owe and the last 3 years cannot be discharge. The GA Dept. of Revenue does not have a good payment plan. They simply take the amount you owe and divide it over 12 mths. to determine your monthly payment. Do I have to file state back taxes to file a chapter 7?

[HHM]

Your attorney is correct, you need the last 3 years of taxes filed, it doesn't matter if you file 7 or 13, the requirement is the same.

[HHM]

But I thought you absolutely HAD to pay back taxes owing to the IRS, i.e. they are not dischargeable in BK.

Basically, the information you have is wrong

[thisguyneedshlp]

If a federal tax lein is filed against you and you dont own ANY assets, could you still discharge the federal tax debt as long as these (4) conditions are met?

1. The 3 year rule. An income tax can be discharged if the Tax Return Due Date is 3 years prior to your BK petition filing date. This rule assumes the tax return was filed.

2. The 2 year rule. For taxes that meet the 3 year rule, but you filed a LATE return, you must wait 2 years to discharge the tax from the date you filed that late return.
Example: You owe for 2002 (hence, Due date was Apr 15, 2003 satisfying the 3 year rule), but you did not actually file the 2002 1040 until April of 2006. That IRS debt can be discharged NOW because you filed the return more than 2 years ago and the due date of the return satisfies the 3 year rule.

3. The 8 month audit rule: If you are audited and ADDITIONAL tax is assessed, you must wait 8 months before you can file a BK petition to discharge that additional tax.

4. The fraud rule: The IRS can challenge the discharge of tax debt if you committed any sort of fraud. Keep in mind, BK fraud is less strenous than regular fraud in that the creditor normally need not prove "actual" intent.

[HHM]

If a federal tax lein is filed against you and you dont own ANY assets, could you still discharge the federal tax debt as long as these (4) conditions are met?

Yes. But you still need to go through the process of valuing the IRS lien. Once the IRS files a tax lien, the taxes become secured debt. As with any secured debt, the lien survives the BK. If you have no assets (keep in mind, for IRS taxes, exemptions DO NOT APPLY), you would need to file a Motion to Value the IRS Tax Lien to establish that the lien has zero or very little value.

[noasset]

I have a question about personal tax refund. I have not filed 2008 taxes and plan to do so before I file C-7.
My question is this. if I have a refund coming can I apply it to 2009 taxes? or would that be a preferential payment? I do understand that a refund typically goes to the trustee, but I would really like to apply it to 2009 taxes.
I was hoping that since it is late enough in the year that I have actually incurred tax liability for this year, it would not be considered a prepayment, even though I am paying it before it is due.
Thoughts?

The flipside would be the possibility of a tax refund this year in which case the Trustee wouldn't like that much lol.

[cinderella]

I messed up on my 2002 taxes big time. I was hoping to get those discharged in a Chapter 7 however I am realizing not that the IRS filed it for me in 2004, NOT ME. I don't know how I missed this. Maybe because they sent me billing statements and I have been paying on it since 2004, now I fear it is not dischargeable. Can someone help me to if the above "3 year" rule still applies if they filed it for me and I did not actually do the filing?

Also, does anyone one if the IRS will let you know which ones are dischargeable and/or set up payment arrangements DURING the BK or after?

Thanks

[Kim2009]

Hi, here is my situiation, my tax file for 2007 is $90k,2008 is $ 40k and i lost my job 2008 June and still no job.I had $10,000 only . I am planning to file Bankruptcy voluntarily. My question is which chapter 11,7,13 is good for me?

[BKin2009]

My husband and I filed BK (chapter 7) in Feb and discharged on May 18th. We had tax debt both joint and individual. I had IRS liens from prior to our marriage. Our attorney filed our debt as unsecured even though I had liens. My own IRS debt was 60,000+ (all liened) and joint of about $2500.00. (not liened). We did not file Motion to Value Lien and were prepared that we would have to make payment arrangements on my tax debt because of the lien.

Monday in the mail I received Release of Lien on all my tax debt. Huge surprise and relief. We were no asset.

[cinderella]

Thanks definitely great news. I am in the EXACT situation and I hope to have to same fortune you did. I owe $51,000 to the IRS all Liened. I owe $14,000 to the state of GA of which ($5,100) is liened. I will ask my attorney about that "unsecured" option you mentioned. Mine are from 2002-2007 and I am hoping to get 2002-2005 discharged. I have no assets also, a house with negative equity.

You said the lien was released but you still have to pay for the recent years that are not dischargeable or are your debt all tax debt over 3 years old.?

Did you have state tax debt also? Were you required to file all your State taxes before you filed?